The Resource CursePerspective on the News
Monday, June 27, 2011Ed DeShields

It was a desperate winner-takes-all gamble this week as the world released its cache of strategic oil reserves in an attempt to stave off higher oil prices. Ultimately, it may be OPEC and the oil speculators, and not the consumer, holding the winning ticket.

Releasing reserve oil wasn’t exactly a high percentage bet. Much like the down-and-out gambler betting his last buck on the Lotto, the world’s leaders decided to dump their meager emergency reserves in hopes it would stop the world’s economy from slipping into the abyss threatened by $100+ per barrel oil prices.

Cutting the strategic reserves around the world is an important decision. It tells us something about what the politicians are thinking. The convergence of macro-economic events this summer may prove to make 2011 a history-making year – in one way or another. Japan is on its back as its people realize that the Fukushima crisis is a real problem. The U.S. debt problem is far worse than imagined. The China miracle looks like a mirage. Europe is desperately holding on by its fingernails to avoid collapse, and the Middle East is consumed with a social brush fires.

To make matters worse, we have an economy that is increasingly trapped by the economics of oil. Higher production costs for cheap oil discourages production while higher prices quickly curtail economic growth. Oil's price is like a shrinking box. Too low and we don't get oil. Too high and the ponzi-scheme collapses. Thus, the desperation of the politicians.

The back-story started earlier in the month when OPEC stunned oil-consuming countries by firmly rejected calls for increased oil production. Saudi Arabia, the only country capable of an legitimate increase in capacity, and Kuwait favored an increase but Iran, OPEC’s new cartel chief said no way – as did all other members.

But, why all the desperation? Lowering prices a couple of dollars per barrel for a month or two doesn’t seem to fully explain the need to sell off our strategic oil supply. The reasoning behind this decision may point to two new dynamics now in play.

First, OPEC oil-producing countries must keep oil prices high to satisfy the socio-economic demands from their people. They rely on their oil exports for 86% of their income. Petro-dictators can only keep the peace if they pay off their constituents with benefits, food subsidies and welfare payments. Simply selling more oil at lower prices is not an option because the output of most OPEC members is declining.

The higher the price of oil the less reliance its dictators have on its people and their tax revenues. Therefore, there is a correlation between loss of freedom and the increase in oil revenues. Kristen Ardani and Benjamin Jaques from the University of California, San Diego School of International Relations and Pacific Studies discovered this relationship in a 2010 study on the Petro-dictators of OPEC.

This “Resource Curse” phenomenon is the root cause of the Arab awakening as the world’s wealth gets transferred from oil-consuming nations to the oil-producing nations. Petro-dictators will do everything possible to keep oil prices as high as possible to preserve their power – and they proved it last week.

Second, the surplus gap between the supply and demand for cheap oil has all but disappeared in the last couple of years. The release of oil stores immediately pushed short-term oil prices on the spot market down just as anticipated. The summer driving and cooling season would have surely driven demand and prices up. Combine higher prices with the loss of QEII’s $6 billion per day in the Fed’s printing press and those increases threatened to sap the strength of a staggering and delicate economy of the verge of collapse.

Unfortunately, the oil futures market (the price of oil one year from now) held steady. And the circling oil sharks know it. Even a junior analyst knows that extra oil will create a temporary gap between today’s lower price and future prices to create an ideal profit opportunity for speculators. It is the ultimate arbitrage.

A similar gap occurred in 2009 where a lull in oil prices had speculators taking delivery of oil and storing it in every available super-tanker in the world. The oil market at that time wasn’t a “glut” of oil but redistribution of oil reserves into the possession of the speculators.

There is a dwindling supply of oil “reserves” as evidenced by the flat production output numbers for the last 6 years. Hence the strategic oil supply will simply be transferred from salt dome storage facilities around the world to super-takers pending its resale in the fall of this year.

The minute oil starts rising again – and it will – the speculators sell into higher prices thereby pocketing the difference. The consumer, or the economy won’t benefit and we’ll be short oil for a real emergency come hurricane season.

Oil is driving the economic bus now and the politicians are helplessly reacting to one crisis after another compounded by the Resource Curse. Unfortunately, there aren’t many good bets left inside the box we’ve found ourselves in.